Volatility continues. Stocks and other risk asset classes fell sharply on Monday as a price war for oil and the ongoing coronavirus fallout rattled financial markets. Stock trading was briefly halted for the first time since 1997 after a tumultuous selloff triggered an automatic curb on trading. Oil prices recorded their biggest one-day decline since the first Gulf War in 1991 after Saudi Arabian state oil giant Aramco cut prices as part of an aggressive campaign to snatch some of Russia’s market share. Interestingly, Monday also marked the 11th anniversary of the closing low of the S&P 500 Index during the Global Financial Crisis, or the start of the longest running stock bull-market in history.
After Tuesday’s almost 5% gain, the broad global equity market (MSCI All Country World Index) is about -15% below the all-time high from less than 20 days ago and down about -12% on a year-to-date basis. “Safe haven” demand has driven down bond yields, resulting in positive returns from investment grade fixed income. At this point, the 10-year Treasury note yields less than 0.75%. Financial markets are clearly pricing in the increased odds of an economic recession.
Obviously the coronavirus outbreak has caused a lot of uncertainty, and we’ve reached out over the last few weeks to share some perspective (see attached). Although it goes along with investing, we acknowledge that experiencing volatility is uncomfortable. From a long-term perspective, history suggests that it’s best to generally hold the course and remain invested to avoid missing the market’s eventual upturn. Particularly during times like these, we rely on a thoughtfully-constructed asset allocation strategy: each portfolio has one based on objectives and risk tolerance, and typically includes a mix of both defensive and growth-oriented assets. Importantly, it’s the asset allocation strategy that provides a framework for making rebalancing decisions and tactical portfolio adjustments.
From a tactical perspective, over the last couple of years we’ve maintained a slight defensive tilt in portfolio positioning with an underweight to equities (US stocks in particular) on valuations. As a result, we actively rebalanced portfolios throughout 2019 by trimming equity positions. Although stock prices are now lower and valuations somewhat improved, we don’t think equities have become cheap enough to become aggressive buyers or to move to an overweight position. However, we do believe the recent market backdrop has presented some opportunities to take action in portfolio strategy.
First, the sharp decline in bond yields has resulted in strong performance from investment grade fixed income securities. And given the now reduced pick-up in yield relative to cash, we are moving forward with trimming positions (by about 2-4% across most portfolios) and taking some gains from high quality bond allocations.
Given the recent weakness in risk assets, portfolios are now generally below our tactical target weights to equities. Therefore, we also plan to start gradually adding back exposure (by about 1.5%-2% across most portfolios). In order to help fund these purchases and raise additional “dry powder,” we recently exited the small allocation to bank loans.
Finally, while most portfolios still have embedded unrealized gains, we are opportunistically looking through positions within each portfolio to harvest tax losses (while simultaneously purchasing similar positions to maintain targeted exposures).
Please don’t hesitate to contact us with questions or if you’d like to further discuss.